US midterms, FOMC loom large in FX

John Hardy

Head of FX Strategy

Summary: A week of potential shake-ups on the US front (Federal Reserve and midterm elections) begins in the shadow of CNY, and China's intentions for its currency.

This week features hefty event risks for global markets, from the US midterm elections on Tuesday to a Federal Open Market Committee meeting on Thursday. Meanwhile, perhaps the biggest question of all remains China’s intentions for its currency and this could remain bottled up for another few weeks.

Friday’s equity trading session on Wall Street saw a development we are likely to see repeated many more time for this cycle: an attempt at a solid extension of the rally off the recent lows that turned badly later in the session – likely at least in part due to an aggressive sell-off in US Treasuries. The 30-year US T-bond yield closed the week at its highest daily and weekly level for the cycle, just five basis points shy of the 3.50% level.

In other words, until we reach a turn in the policy environment from here, the risk is that whenever risk appetite makes an attempt to signal the all-clear, rising bond yields will swoop in and cap the enthusiasm. The Fed’s policy tightening and the weight of US Treasury issuance provide a countervailing force, in other words.

In currencies, we saw Friday’s’ turn supporting the US dollar from its bout of weakness (which was inspired by China pulling the CNY off the floor rather aggressively on Thursday).

China is doubling down on signalling that it wants to be seen as the “adult in the room” in trade negotiations, as Chinese leader Xi Jinping spoke at the Shanghai Expo conference, criticizing protectionism and promising a cut to tariffs. No word on the country’s current policy of strict policy controls and its artificial support for its currency, however, and many downplayed the significance of the Chinese leader’s rhetoric

Italy’s yields have dropped to their lowest in weeks despite lack of any real progress on the budget showdown. The Five Star Movement’s Di Maio was out encouraging a change of attitude in the European Union on austerity over the weekend. The FSM is struggling for additional traction with the latest Ipsos poll suggests that support for Lega is at nearly 35%, while the FSM polls at a still respectable 28% – a combined result well above 60% versus only around 50% at election time. Given the Lega’s massive doubling of popularity since the election, there are concerns that the governing coalition is unstable.

The budget issue risks generating further headlines this week as Italian Finance Minister Tria is in Brussels defending Italy’s budget intentions after the EU rejected its initial budget submission.

Tomorrow’s US midterm election will dominate the headlines early this week and into the tallying of results into Wednesday. The strong consensus is that the Democrats will take a clear if still slim majority in the House and will not capture the Senate. But as we suggest in our recent special midterm election update, the surprise risk leans in favour of the Democrats, given reports of heavy early voting turnout by young and women voters relative to past cycles. The turnout factor, particularly among voters that have never voted before, is the wildcard that could prove decisive, just as Clinton’s inability to inspire turnout was a critical factor in her loss in the 2016 presidential election.

Chart: USDJPY

If US long yields continue to press higher and the Bank of Japan holds the line on its yield curve control policy, the yen may continue to absorb the pressure. Last week’s high above 113.30 was the 61.8% Fibonacci retracement of the sell-off from the top and provides a tactical pivot that could lead to a test and then some of the big overhead range resistance around 114.50. Thursday’s FOMC meeting is likely the deciding factor this week on USDJPY direction.

Source: Saxo Bank

The G-10 rundown

USD – given last week’s strong earnings data (both the Average Hourly Earnings and Employment Cost Index data series), wouldn’t expect any change to the Fed’s hawkish stance. As for the midterms, an earthquake in favour of the Democrats is a bit tough to price, but could mean a weaker US dollar if the fear is that the Dems will launch an aggressive campaign to take down Trump.

EUR – 1.1450-1.1500 is the local resistance and pivot area for EURUSD – have a hard time seeing the Euro aggressively stronger in a rising US yields environment, unless an unlikely breakthrough materializes in Italy’s budget negotiations or China makes a more aggressive move to boost the renminbi.

JPY – rising yields the chief focus for the yen, and a strong headwind for the currency if the continue to rise. The USDJPY focus will be on the next hurdle – the big 114.50 range high that stretches back to early 2017.

GBP – the market maintaining a positive spin on Brexit, but we agree with noted money manager Steve Eisman, who suggests that the risk is the parliamentary vote more than whether the May government and the EU can cobble together an agreement. Eisman is betting on a hard Brexit.

CHF – fading Italian core yield spreads and higher US yields pressuring the CHF and keeping USDCHF above parity at the moment, while EURCHF is a tough on to see above 1.1500 without some political breakthrough in Europe.

AUD – the Aussie saw a sharp squeeze last week triggered by crowded speculative shorts and China showing support for its currency. Not sure how much more fuel is in that move, but not at all convinced we have seen the lows for the cycle. Hard to see why the Reserve Bank of Australia changes its tune at its meeting tonight, given concerns that the Australian housing market bubble may finally be unwinding. As well, the latest Caixin Services PMI out of China was at a weak 50.8 versus 52.8 expected and 53.1 in September.

CAD – the loonie struggling a bit in relative terms on weak oil prices and the USDCAD is the opposite of a thing of beauty. Jobs data on Friday was uninspiring. The RBNZ up early Thursday, likely with little new to say.

NZD – playing keep-up with the Aussie at the moment as AUDNZD trades with the lowest volatility ever – is there a plan to peg the kiwi to the AUD at 1.0850 afoot (I'm joking, but there hasn’t been a reason to trade the kiwi in a long time).

SEK – the krona getting a bit more traction and looks ready to break the 200-day moving average and sub-10.30 lows this week if markets avoid any fresh meltdown in risk appetite or spike in EU existential woes (We are ambivalent on how the market trade the latter: as we have discussed – the primary concern for the krona on EU existential concerns has been on the implications for Sweden’s economy – but recall that in the past cycle peaking in 2012, the krona showed very different stripes as a safe haven from EU existential worries).

NOK – we still like a repricing of EURNOK lower, but NOK’s prospects not compelling at the moment as crude oil prices have collapsed on strong supply news and the US announcing waivers for eight nations purchasing Iranian crude.

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